Egypt's Power Vacuum Threatens the Economy

Investors cheered after Muslim Brotherhood candidate Mohamed Mursi was declared the winner of Egypt’s presidential election on June 24. The benchmark stock index soared 7.6 percent, the biggest gain since February 2008, and rose another 2.9 percent on June 26. The celebrations may prove premature should a battle over legislative power, currently held by the military, impede Mursi’s ability to follow through with campaign promises to reduce public debt, create jobs, and boost economic growth.

A standoff between Mursi and the military could delay a $3.2 billion International Monetary Fund loan needed to stem the worst decline in foreign reserves since 2004 and to cut record borrowing costs, according to economists at Bank of America (BAC), HSBC Holdings (HBC), and Standard Chartered (STAN). The budget deficit may widen to 10 percent of economic output this year, the highest for any Arab country, according to IMF forecasts. “The current institutional vacuum could jeopardize the very crucial aid and budget support that had been in the making for months now,” Philippe Dauba-Pantanacce, Dubai-based senior economist at Standard Chartered, said by e-mail on June 24. “In the short term, Egypt could be on a verge of a disorderly devaluation, with foreign exchange reserves dangerously low.”

At stake for Mursi, 60, are promises he made to voters who toppled Hosni Mubarak in a popular uprising last year in protest of policies they said swelled the pockets of the rich and left the poor grappling with unemployment, inflation, and police repression. As part of his platform, Mursi pledged to create a fund for unemployment benefits, boost economic growth to 7 percent a year on average, from 1.8 percent, and cut the budget gap to less than 6 percent of gross domestic product by 2016.

Foreign investment in government debt almost vanished after the revolt, and along with it more than half of the country’s foreign reserves. The latter slid to $15.5 billion in May from $36 billion on the eve of Mubarak’s ouster, central bank data show. Egypt’s borrowing costs have soared over the 17 months since the uprising. The average yield on nine-month, local-currency treasury bills rose to a record 16 percent at a sale hours before Mursi was declared the winner on June 24.

The Muslim Brotherhood has vowed to continue a sit-in in central Cairo’s Tahrir Square until the Supreme Council of the Armed Forces, or SCAF, reverses its declaration to take over legislative powers, made after a court ruling effectively dissolved parliament this month. The military retained veto powers over the drafting of a new constitution. The nation’s budget for the fiscal year starting July 1 also needs military approval in the absence of parliament, according to former lawmaker Ziad Bahaa-Eldin.

“We cannot view the election result as establishing a new order in Egypt or ending the power struggle between SCAF and the Brotherhood,” HSBC economists wrote in a June 25 report. At best, Mursi’s win may pave the way for the two groups to work out an “uncomfortable modus operandi that could allow for the formation of a new, Islamist-led coalition government willing to rule within boundaries agreed with SCAF,” they said.

Investors are keeping a watchful eye on developments. “First news seems to be positive for Egypt’s bonds, but the euphoria can be set back quickly” if the ongoing power struggle between the president and the military is not resolved, says Sergey Dergachev, who helps manage emerging-market assets at Union Investment Privatfonds in Frankfurt. “I do regard this risk as real, and still maintain a cautious stance on Egyptian assets.”

Egypt first requested a loan from the IMF last year. The IMF linked its approval to Egypt’s achieving broad political consensus. On June 26 the agency said it’s ready to support the country in the face of “significant immediate economic challenges.” The Muslim Brotherhood had said it didn’t want IMF funds disbursed to a military-appointed government. While that government is on its way out, in the absence of a parliament it is not clear when or if the loan will go through. The “constitutional vacuum and the lack of parliament or clearly defined presidential powers could likely delay the program further,” Bank of America analysts wrote in a June 26 report. “Time is not on Egypt’s side.”

The bottom line: While stocks climbed more than 10 percent after Mursi was declared president, investors are nervous about his ability to govern.

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IPOs' Job-Boosting Power Is Overblown

When President Obama signed the JOBS Act to make it easier for young companies to go public, he said it “will help entrepreneurs raise the capital they need to put Americans back to work.” Give fast-growing companies easier access to money from public market investors, the thinking goes, and they will expand faster and hire more people. Research published (PDF) by the National Venture Capital Association says that “92 percent of job growth for young companies occurs after their initial public offerings,” suggesting that a company with 100 employees at its IPO could expect to hire an additional 900 in the years that follow. The 92 percent figure was cited prominently (PDF) in lobbying efforts supporting the JOBS Act.

A new report (PDF) from the Kauffman Foundation, which promotes entrepreneurship, suggests the estimate is overblown. “Conventional wisdom is that companies going public create a lot of jobs,” says Jay Ritter, a University of Florida finance professor who co-authored the study. “The numbers that the venture capital lobby keep repeating are grossly overstated in terms of what the average IPO can accomplish.”

Ritter and his co-authors found that companies that went public from 1996 to 2010, in aggregate, increased employment by 45 percent over their IPO headcount. Many of those public offerings, though, were not from “growth” companies but from other sorts of businesses, ranging from leveraged buyout targets to mature companies like UPS (UPS), which was founded more than 90 years before it went public in 1999. Growth companies, which Ritter defines as less than 30 years old (and excluding buyouts, spinouts, and the like), more than doubled employment from their IPO levels through 2010. Still, the Kauffman paper says such companies didn’t have anywhere near the nine-fold employment growth that the NVCA reports they enjoyed after going public.

That figure comes from research by IHS Global Insight, which the NVCA commissioned in 2009. IHS Vice President Mark Lauritano told me the firm measured growth in employment at the 200 venture-backed companies with the largest market caps, counting from the time of their IPOs from 1970 on. It didn’t include results from companies that failed or from smaller companies. “This study does have a built-in survivor bias,” Lauritano says. “The 90 percent growth figure really represents the upper end of the range for job creation because it is based upon the largest publicly traded VC-backed companies that ‘survived’ the ups and downs of the business cycle,” he wrote in an e-mail.

That doesn’t mean the slower pace of public offerings over the last decade hasn’t affected job growth. The Kauffman paper estimates that if companies had gone public in the first decade of the 21st century at the same rate they did between 1980 and 2000, those companies would have created an additional 1.9 million jobs. “It is important to have a working IPO market to facilitate venture capital fundraising and investment,” Ritter says. “If VCs don’t have that exit possibility, it’s going to make it more difficult to raise money to invest in startups.”

Making it easier for more startups to go public, though, may not put as many people back to work as supporters of the JOBS Act thought.

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The Power Curve: Smart Investing Using Dividends, Options, and the Magic of Compounding

In this valuable book, professional money manager Scott G. Kyle explains in entertaining and understandable terms how to tap into the ultimate strength of compounding to improve your stock market returns. Kyle describes how to construct a portfolio, analyze companies, and utilize options - all with the goal of giving you the tools to become a great trader and investor.

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Lagarde Signals to IMF Staff More Power for Emerging Markets

July 01, 2011, 1:48 PM EDT By Timothy R. Homan and Sandrine Rastello

July 1 (Bloomberg) -- Christine Lagarde signaled that as the new head of the International Monetary Fund she will follow through on a promise to increase the stature of emerging-market nations at the global lender.

Lagarde, speaking to IMF staff in a video message, distanced herself from her previous role as French finance minister and indicated she would advance efforts to give more voting power to countries such as China and Brazil, according to a transcript obtained by Bloomberg News yesterday. Her five-year term begins on July 5.

“The transformations that have taken place in relation to governance for instance, must be pursued, must be continued, so that the fund does belong to its 187 members,” Lagarde, 55, said. “I am not the director of a particular group of countries. I am the director of the entire institution.”

In the course of an election-style campaign that took her to Brazil, China and the Middle East, Lagarde promised to boost the clout of developing nations at the IMF. In doing so she garnered endorsements from emerging economies as well as European Union countries and the U.S.

Lagarde was selected over Agustin Carstens, Mexico’s central bank governor. Emerging markets failed to rally around a candidate from among their ranks, after calling for an end to Europe’s six-decade lock on the position.

Candidate Lagarde

As a candidate, Lagarde also said she would push for quick implementation of a 2010 agreement that makes China the third- strongest voice in the organization and gives more say to nations such as South Korea. The 2010 agreement also weakens the influence of advanced European economies, which pledged to reduce the number of seats they hold on the IMF’s 24-person executive board.

“I am very concerned that we can enrich the institution as much as we can by using diversity as an asset,” Lagarde said, according to the transcript of the video message. “Gender, geography, academic background, culture -- all that diversity should actually be mixed so well that it produces this unbelievable intellectual talent that you together can produce.”

Women accounted for 45.5 percent of the IMF’s staff and 21.5 percent of its managerial jobs at the end of 2010, according to the organization’s annual diversity report, which also called the number of employees from emerging-market countries “unacceptably small.”

Lagarde is the first woman to head the IMF. She replaces Dominique Strauss-Kahn, who resigned after his arrest last month on charges that include attempted rape. He has pleaded not guilty.

“I know that recent events have not been particularly pleasant for any of you nor for the institution as a whole,” Lagarde said to IMF staff, without mentioning Strauss-Kahn by name.

--Editors: Christopher Wellisz, Kevin Costelloe

To contact the reporters on this story: Timothy R. Homan in Washington at thoman1@bloomberg.net; Sandrine Rastello in Washington at srastello@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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The Power of Passive Investing: More Wealth with Less Work

A practical guide to passive investing

Time and again, individual investors discover, all too late, that actively picking stocks is a loser's game. The alternative lies with index funds. This passive form of investing allows you to participate in the markets relatively cheaply while prospering all the more because the money saved on investment expenses stays in your pocket.

In his latest book, investment expert Richard Ferri shows you how easy and accessible index investing is. Along the way, he highlights how successful you can be by using this passive approach to allocate funds to stocks, bonds, and other prudent asset classes.

• Addresses the advantages of index funds over portfolios that are actively managed
• Offers insights on index-based funds that provide exposure to designated broad markets and don't make bets on individual securities
• Ferri is also author of the Wiley title: The ETF Book and co-author of The Bogleheads' Guide to Retirement Planning

If you're looking for a productive investment approach that won't take all of your time to implement, then The Power of Passive Investing is the book you need to read.

Q&A with Author Rick Ferri

Author Rick Ferri

What is passive investing?
Passive investing is about achieving the returns you need in the markets by using low cost index funds and exchange-traded funds. Passive investing is all about earning your fair share of financial market returns whether the market is US stocks, international stocks, bonds, commodities, or any combination of those investments.

The opposite of passive investing is active investing. This is the act of trying to beat the markets by using an infinite number of higher-cost strategies that probably won’t work. Nobel Laureates in Economics have been telling us for decades that passive investing is a better investment strategy than active investing. The Power of Passive Investing brings many of those studies together in one book.

How is this book different from your previous ones, such as The ETF Book, All About Asset Allocation, and All About Index Funds?
My previous books explain how to select low-cost index funds and ETFs, and how to create a portfolio using these funds. The Power of Passive Investing provides the proof about why this is a superior strategy to trying to beat the markets. The evidence in the book is irrefutable.

Who is the target audience of this book?
The Power of Passive Investing is written for any investor who wants to understand more about the mutual funds they are investing in, including people who have a 401(k) or similar work savings plan. It’s also an important book for brokers and consultants who make a living recommending mutual funds and ETFs, as well as banks, trust departments and investment advisors who manage other people’s money. Finally, it’s a particularly important book for people who oversee endowments, foundations, and pension funds.

An observation you make is that while it’s possible to beat the market, it’s not probable. What are the odds a mutual fund will beat the market?
Mutual fund companies that try to beat the market argue that it’s possible to do so. They are right. It is possible; it’s just not probable, and the payout stinks.

Active managers often point to Warren Buffett, the famous CEO of Berkshire Hathaway as an example. They imply that since Warren beats the markets that we should believe that they, too, will win. That’s nonsense. Here are three reasons why it can’t be true:

• About one-third of mutual funds go out of business every 10 years, and about 50 percent are defunct after 20 years.
• Only about 1 in 3 of the surviving funds outperform index funds. Surviving funds are the ones that don’t close, and it assumes you know which ones those will be, which is not possible.
• The excess return from the winning surviving funds doesn’t come close to the shortfall from the losing funds, and this is before accounting for the losses in the defunct funds before they closed.

The Power of Passive Investing explains the near certainty that a portfolio of index funds will beat a portfolio of active funds over time. Tell me about this conclusion.
We’ve addressed one mutual fund versus one index and the low probability for active fund success. But that’s doesn’t define the whole problem because people don’t own just one mutual fund. They own several funds across diversified asset classes such as US stock, international stock, bonds, real estate, and so forth.

Having several active funds in a portfolio exponentially lowers the probability that the portfolio will beat a comparable index fund portfolio. As more active funds are added, and the longer their held, the probability that a portfolio of index funds will outperform the active fund portfolio increases dramatically to the point where the index funds have a 99 percent probability of outperforming a comparable portfolio of active funds. Now that’s something that all investors should consider!

Why do active investing strategies fail to beat the market for the vast majority of investors?
There are several reasons that active funds fail to deliver, not the least is the cost of trying to beat the markets. Hundreds of thousands of investment managers, investment advisors, brokers, mutual funds manager, pension funds managers, banks, trust departments, individual investors, traders, etc., are attempting to out-fox the markets. They spend hundreds of billions of dollars each year trading securities, paying managers and consultants, buying research, etc. The cost of trying to beat the market makes doing so impossible for most people.

A second reason investors fail to beat the market is due to poor behavior. They seek high returns by looking in the wrong places for outperformance. Active investors chase after past performance, they chase star ratings, and they chase the news. They’re putting money in places today where they should have already had money. This tail chasing game costs investors dearly.

You make the case for low-cost index funds. But mutual fund fees aren’t the only cost. What other costs do investors bear?
There are trading costs, commissions, advisor fees, taxes, 12b-1 fees, administrative costs, research costs and the list goes on. Much of these costs are hidden from investors. For example, most investors in 401(k) plans don’t provide investors good transparency on the costs they’re paying.

Another bastion of gluttony is high advisor fees. This issue is just starting to come out in the media. The typical investment advisor charges one percent per year to manage a portfolio of mutual funds for clients. That’s crazy-high given the huge advances in portfolio management software and other technology that have occurred over the years. Advisors today should be able to handle five times the amount of clients with half the amount of staff than they did in the 1990s. These productivity gains have not been passed on to clients in the form of lower fees.

What should investment advisers charge their clients?
Well, it’s not one percent, which is the ‘standard fee’ you’ll hear in the marketplace. I believe Investors shouldn’t pay more than 0.5 percent per year to an advisor, and probably less. My firm, Portfolio Solutions, charges only 0.25 percent in annual fees. We’ve been charging this low fee for more than a decade, and it has saved our clients millions of dollars over the years. That’s real money is in their pockets.

Why do so many people try to beat the market if the proof that passive investing outperforms active investing is irrefutable?
There’s big advertising dollars promoting active management - much more than passive managers can afford. Remember, actively managed funds charge 5 to 10 times the fee of a comparable index fund. Much of this huge revenue stream is spent bombarding the public with nonsense about how active mangers can beat the market, and it basically ensures that the truth about passive investing gets lost in the noise.

Did you know that for every new book published on passive investing there are at least a dozen books published on how you can beat the market? Did you know that for every media interview with a passive investing advocate like myself there are at least 100 interviews with people who claim they can beat the market?

It’s actually amazing to me that any information about passive investing gets to the public, and it’s a credit to investors who have looked beyond the smoke and mirrors.

How can someone adopt a passive investment strategy? What’s the first step?
The answer is to start learning the real facts about the markets and investing. You can start with The Power of Passive Investing if you’re already knowledgeable about mutual fund investing. I’ve also written several how-to books on low-cost index fund investing, exchange-traded funds, asset allocation and planning for retirement.

Price: $29.95

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Reduce Risk to Supercharge Your Investment Returns Through the Power of Compounding

Successful investing is all about the effective management of risk. Managing risk and avoiding large losses can have a tremendous impact on the growth rate of your investment portfolio over the long term.

Your financial advisor may be telling you that to be a “growth investor”, you need to increase your tolerance for risk and be willing to live with portfolio losses on the order of 30% or more when the market goes down.

But to really super-charge your long term investment returns, your tolerance for risk should probably be less than you think …

The point of this article is to understand how risk and losses affect the rate of growth in your portfolio… and what that means for the risk tolerance you should have. If you are a “growth investor”, then you need to understand this basic principal.

Doesn’t Growth Investing Mean Taking More Risk? Our ideas may conflict with what you think you already know about “growth” investing. You probably know that “growth” type investments are riskier, so how can you keep your risk tolerance at a low level and also invest in these riskier growth investments?

We are here to tell you that too much risk will hurt your long-term growth prospects. By using new, more advanced forms of active investment management based upon market timing, a growth investor can reap the benefits of investing in growth-type investments and also keep their risk tolerance at a low level.

This new approach allows you to harness the power of compounding, capture the superior gains of growth investments and multiply profits on top of profits – accelerating the growth of your nest egg with relative safety.

If you don’t think you could learn how to apply a more advanced approach to your investing, don’t worry. There are various investment newsletters and advisory services that will simply tell you what to do. Alternatively, there are money managers you can hire that use the new, advanced techniques.

Compounding Earnings Creates the Magic

You can read entire books on how to use the “magic of compounding” to get rich. You can become a millionaire by putting away a moderate amount of savings for 30, 40 or 50 years, investing the money at some moderate level of interest rate, and reinvesting the earnings in each period.

The books always point out that the key to the “magic” is reinvestment. Rather than spend the interest you earn, reinvest the earnings back into the same investment. In each period, your earning investment balance goes up by the amount of earnings in the previous period. Because the earning balance goes up each period, you earn more interest in each successive period.

• This power of multiplication will start to accelerate your portfolio growth from period to period and lead to a much larger investment balance than if you hadn’t been reinvesting.

To make the connection between your risk tolerance and the power of compounding, we need to look inside the mathematics of compounding just a bit. There we will find out what really makes compounding work and it will help us understand why managing risk is so important.

Losses Reduce the “Earning Balance”

What is the connection between losses and compounding? It’s simple really. When you lose money in your investment account, you reduce the earning balance.

• It’s the opposite of what happens when you reinvest your earnings.

The mathematical power behind compounding is … the steady growth of your earning balance. When you reinvest earnings, you provide a larger investment balance upon which to earn a return. And here is the key mathematically:

Your returns are more sensitive to the SIZE of your earning balance than the size of the investment return in any given year.

Size Matters: If you start with $100 and lose 10%, you are left with $90. If you earn 15% in the next year, you will make back $13.50 and have an ending balance of $103.50. Alternatively, if you started with $100 and lost 50% instead, you would have reduced your earning balance to only $50. If you then made the same 15% during the next year, you would make only $7.50, rather than $13.50 and end up with a balance of only $57.50.

Losses Destroy Principal Which Must Then Be Replaced. But here is the key “math” thing to understand: the reduced principal, or earning balance, makes it harder to earn the money back and replace what you lost.

You can look at the problem this way: If you lose 10%, it will take a gain of 11.1% to get back to “break-even”. However, if you lose 50%, it will take a gain of 100% to get back to even. It is much easier to earn an 11% return than 100%.

• When you lose a large percent of your portfolio … you have lost the power of compounding for multiple years and significantly reduced the long-term result you can achieve.

So the point of effective risk management is to avoid the big losses.

Increase Your Upside With a Lower Risk Tolerance

So what are these advanced investment methods that can allow you to invest in riskier “growth” type investments while avoiding very much risk to your portfolio?

They are active portfolio management strategies that use various market timing techniques to get you in and out of different investments. Many of these methods use computerized statistical models that identify longer-term market trends. They don’t try to “crystal gaze” the future. They simply statistically identify market trends and tell you when to get in or out.

By knowing when to get out before your investment gets slammed, the active portfolio management techniques significantly reduce risk.

In effect, they allow you to include riskier “growth” type investments without having to suffer the inevitable penalty of high volatility and steep losses during “bear markets”.

To learn more about our growth investment strategies for stock market and mutual fund investing subscribe to our free strategic investment newsletter [http://www.confidentstrategies.com/free_newsletter.htm] at http://www.confidentstrategies.com.

ConfidentStrategies.com founder Mark Kramer has over 24 years of experience in the Financial Services industry. He was most recently a licensed Registered Representative with a predecessor firm of JP Morgan Chase. Mark intends to share his investment knowledge and research to help investors make smarter investment choices in the stock market and mutual funds. If you would like to learn more about investing in the stock market and mutual funds visit http://www.confidentstrategies.com to sign up for our free investment newsletter.